I have been working on a book about my acquisitions and other business deals
and, as in the attached chapter, some deals of others that I have liked. My
general theme is how an ordinary guy, without sizable capital or the backing of
a well-known financial institution, can accomplish deals with large public
companies. While I think the individual chapters tell interesting stories, it is unclear
to me what the overall market for such a book would be. Who exactly would pluck
down his or her money for a book with such a title or theme? Perhaps readers of Victor’s and Laurel’s Daily Speculations website will have
some ideas along this line. Also, since each chapter is a working draft, I would
be grateful for any comments from readers on ways to add to or improve the
chapter. Many thanks -- Dan Grossman <dvgman [@] gmail.com>

Chapter X

A Deal I Wish I’d Done

What was the best deal ever? When magazine articles ask this question, they
usually cite such historic deals as the purchase of the Louisiana Territory from
France, or the purchase of Alaska from Russia.

Viewed as purely a real estate transaction, it is hard to argue against the
1803 purchase of the Louisiana Territory as history’s greatest deal. For a
purchase price of $15,000,000, consisting of $11,250,000 in cash and $3,750,000
in assumption of claims of American citizens against France (whatever exactly
that means), the United States acquired the entire area from the Mississippi
River to the Rocky Mountains, a total of 600,000,000 square acres. The
transaction doubled the size of the U.S., and instantly made it one of the
largest nations in the world. Thirteen large and prosperous states were
eventually carved from this purchased territory.

But is it fair to put a rearrangement of the globe negotiated between
sovereign nations in the same category as a business deal that you or I could
conceivably do (assuming the financing could be arranged)? I think not, for
reasons as obvious as noting the negotiators on each side: Napoleon and
Tallyrand for the French, and Jefferson and Monroe for the Americans. If
President John Kennedy was correct in his welcome to a gathering of Nobel
prize-winners – that they represented the greatest collection of intellectual
talent at the White House since Thomas Jefferson dined alone – then the combined
abilities of the Louisiana Purchase negotiators probably exceeded by a
substantial margin that of the Business Roundtable or any collection of business
dealmakers you wish to name.

Even assuming business dealmakers of the caliber of Jefferson and Napoleon,
they are at a considerable disadvantage to national leaders in that they do not
possess the powers of great armies and populations available to governments.
Surely this was a major factor influencing the Louisiana Purchase negotiations.
The Louisiana Territory was too far from France and too indefensible by it on a
long-term basis in the face of an expansionary United States. Since it was
probably inevitable that the Territory would someday be part of the U.S., either
with or without France’s acquiescence, this underlying reality had to affect
both France’s willingness to sell, and the price it could realistically hold out
for. Thus the terms won by Jefferson cannot be compared with the terms available
in a private business transaction.

The same was undoubtedly true of the purchase of Alaska, which could rank a
close second to the Louisiana Purchase if viewed as a pure real estate
transaction. After some years of off-again, on-again negotiations interrupted by
the Civil War, in 1867 the U.S. purchased Alaska from Russia for $7,200,000. The
land mass acquired was equal to one-fifth the size of the continental United
States, for a price of about two cents per acre. This was less than the two and
a half cents per acre price paid for the Louisiana Purchase, but a significant
part of the Alaska is under ice. On the other hand, Alaska turned out to be a
tremendous repository of oil and other natural resources. From a real estate and
asset standpoint, you have to rank the Alaska purchase right up there with
Louisiana as among the greatest deals in history.

But what was the full story of the Alaska purchase? What were the pressures
and implied threats that influenced the negotiations? During a vacation trip to
Sitka, the former Russian capital of Alaska, I looked around in museums and
bookstores trying to find out. One old governmental book, containing part of the
transcript of the negotiations in Washington between U.S. and Russian diplomats,
caught my eye. In the transcript was a discussion that I would never have
associated with Russian Alaska, a discussion about the Mormons.

In the 1860s the Mormons were what today would be considered a large and
scary cult. Persecuted for their unorthodox religious beliefs and practices, the
Mormons had left the populous parts of the U.S. by wagon train to create their
own society in the Utah desert. But the murderous attacks on them by their
neighbors had caused the Mormons to respond in kind. By the time they were
established in the desert, they had become fierce fighters, massacring other
settlers’ wagon trains and even attacking the U.S. Cavalry.

In the transcript, the American diplomats were discussing the Mormons and the
probability that they would move on from Utah further into the Northwest, in
order to isolate themselves from the growing influx of other American settlers.

“Not into Alaska!” the Russians reacted, presumably fearful of the
possibility that their sparse fur-trapping settlements would be overwhelmed by
these well-organized, heavily-armed zealots.

“Maybe the Oregon Territory, maybe Alaska,” responded the American
negotiators, turning the screws on the apprehensive Russians.

This not-so-subtle “playing the Mormon card” in the diplomatic transcript was
enough to convince me that there was more than $7,200,000 involved and that, as
in the case of the Louisiana Purchase, the geopolitical reality of who could
take what from whom was a major influence underlying these sovereign purchases
of vast territories.

A Famous Leveraged Buyout

If not territorial purchases then, would one of the famous leveraged buyouts
of the 1980s qualify as the best deal of all time? Leveraged buyouts, or LBOs,
thrived during the relatively low public stock market prices of the 1970s and
1980s, and involved the purchase of asset-rich companies by putting up as little
equity capital as possible and borrowing heavily against the assets being
purchased.

Kohlberg Kravis Roberts did the largest deals (Beatrice, Safeway, Duracell,
RJR Nabisco) and was by far the best-known LBO firm. But it was Wesray Captial’s
purchase of the Gibson Greetings card company, an acquisition and subsequent
public offering in which Wesray’s equity investment of $660,000 grew to more
than $140,000,000, that was the signature LBO of the 1980s. And it was New York
magazine’s cover story on the deal that first revealed, not only to the public
but to many financial players as well, the extraordinary profits LBOs were
capable of generating.

Wesray was a partnership formed in 1981 by former Treasury Secretary William
E. Simon and a young dealmaker named Ray Chambers (WES + Ray). While I never met
either of these New Jersey neighbors of mine, it was my distinct impression that
Chambers was the hardworking brains of the partnership and Simon was there to
lend his high-profile name and credibility to Wesray’s “smoke and mirrors”
leveraged deals. Simon had been something of a loudmouth in the Nixon and Ford
administrations and, while posing as a staunch advocate of free markets, had
actually been a prime architect of the government’s disastrous gasoline market
intervention during the 1973-74 oil crisis. “I’m the guy who caused the lines at
the gas stations,” he idiotically boasted.

Gibson Greetings was Wesray’s first deal and what provided the purchase with
its underlying favorable economics was that Gibson was owned by RCA. Given that
RCA’s acquisition of a greeting card company made absolutely no sense to begin
with, it was hardly surprising that RCA would decide to unload the company at
precisely the wrong time – just when Gibson was gaining market share based on
its license of Garfield and other popular cartoon characters, and just at the
1982 start of an 18-year bull market. The purchase price to Wesray was
$80,500,000, but Wesray was able to finance 99% of this, putting up only
$660,000 of a total of $1,000,000 in equity capital. And importantly, this
financing was entirely without liability or personal guarantees by Wesray, Simon
or Chambers – the lenders were willing to assume 99% of the downside risk,
looking solely to Gibson Greetings’ business and assets for repayment.

$13,000,000 of the financing for Wesray’s purchase price came in an equipment
mortgage from Barclay Bank. The remainder came in a so-called “mezzanine”
financing (that is, intermediate level financing between conventional debt and
equity) from General Electric Credit Corp. GE Credit was willing to provide such
a large loan because Wesray allotted it the remainder of the equity in Gibson,
and because Wesray was simultaneously arranging to raise $31,000,000 from a
sale-and-leaseback of Gibson’s real estate, which amount was immediately turned
over to GE Credit to pay down its loan to a tolerable level.

Wesray’s purchase of Gibson closed in January 1982, and just thirteen months
later it was able to complete an initial public offering of Gibson shares at a
price which valued Chambers’ and Simon’s shares at $130,000,000. These shares
were sold off by Chambers and Simon in the initial offering and over the next
four years for a total of $140,000,000. By then the partners had been feuding
for some time, mainly over Simon’s abusive treatment of Chambers, Wesray
employees and pretty much everyone else he came in contact with. In a 1985
letter, Chambers told Simon that he “never minded ‘being in the trenches’ and
being responsible for getting the deals done and then making them work [while
you basked in] the Wesray limelight.” But given Simon’s behavior, Chambers
wrote, it was time to terminate their relationship as to all future
transactions. After the split, Simon tried to continue doing deals with other
partners and on his own, but in a few years Forbes dropped him from its 400
wealthiest Americans list citing “bad investments”.

Wesray’s cash-on-cash gain from $660,000 to $140,000,000 was certainly
extraordinary but the extraordinariness was almost entirely dependent on
leverage. Without leverage the $80,500,000 purchase price paid for Gibson
Greetings appreciated over four years to $140,000,000, a compound annual gain of
slightly more than 20% but not a transaction you would select for consideration
as the best deal ever. From my perspective, I would prefer to nominate a deal
that a regular business owner like me, not a famous former Treasury Secretary,
could finance and close. And even though I probably have one of the best records
in the country in buying and building businesses, I can assure you that no bank
or finance company would ever lend me $79,500,000 of a $80,500,000 purchase
price.

The Spirits of St. Louis

The deal I nominate is not the Louisiana or Alaska purchase, and not Gibson
Greetings or some other famous leveraged buyout. It is a transaction that even
plugged-in dealmakers have probably never heard of. It is the buyout of the
Spirits of St. Louis basketball team in the 1976 merger of the American
Basketball Association and the National Basketball Association.

The ten-year saga of the ABA from founding to merger was probably as close to
pure frontier capitalism as one could get in late twentieth century America. In
1966 the NBA had only twelve teams across the entire U.S. Seizing the
opportunity to expand to additional cities, a motley collection of basketball
enthusiasts – businessmen looking to add glamour to their lives, speculators
hoping for a quick merger with the NBA – came together to form eleven new teams
in a league they named the American Basketball Association.

The ABA competed with the NBA for college basketball stars, drafted and
signed leading players from the NBA itself, brought lawsuits against the NBA for
antitrust violation, and in turn had to defend against multiple lawsuits brought
by the NBA. Legal expenses were running in the millions.

True to its role as an innovator, the ABA pioneered changes that improved and
added excitement to the game. The most well known was the three-point shot, a
scoring change eventually adopted by the NBA and by all of college and high
school basketball. Slam dunk contests at ABA All-Star Games proved highly
popular with spectators and players alike. And the ABA’s wide-open style, as
exemplified by the league’s best player, Julius Irving, Doctor J (“he operates
on his opponents”), came to significantly affect play in the NBA, which had
initially dismissed the ABA as amateurish.

Many of the ABA teams were seriously under-financed. Although they signed
leading players to million-dollar, deferred-payment contracts, teams sometimes
struggled to come up with a few hundred dollars to pay creditors threatening to
foreclose on their uniforms or otherwise shut them down minutes before a
scheduled game. Star players, even including Doctor J, were sold off so that a
team could survive for the following season. Teams were sold and resold,
relocated to new cities overnight, or closed down entirely. But the more
successful and well-run ABA teams like the Indiana Pacers and the San Antonio
Spurs attracted loyal fans and provided them with exciting, high-level
basketball.

Three-point shots, slam dunks, million-dollar contracts, sex, drugs – in the
midst of this chaos and excitement two brothers in the textile business in New
York, Dan and Ozzie Silna, and their lawyer, Donald Schupak, decided they wanted
to own a professional basketball team. An inexpensive way into the ABA presented
itself in 1973 when the Carolina Cougars were close to being dismantled after
selling off a number of their leading players. For $500,000 in cash and an
additional $1,000,000 to be paid over time, the Silna group purchased what was
left of the team and moved it to St. Louis, at the time the largest U.S. city
without a pro basketball team. They renamed the team the Spirits of St. Louis,
after Lindbergh’s famous plane that carried him on his solo flight across the
Atlantic.

To make their team competitive, the new owners quickly went after leading
players, successfully signing Marvin Barnes, the second pick in the NBA draft.
With the nickname Bad News Barnes, he was a six-foot-nine forward of prodigious
talent but perhaps the most undisciplined player ever to play pro basketball,
which is saying quite a lot. Barnes would typically emerge from his hotel room
late in the day with a woman on his arm (sometimes more than one), with only the
vaguest sense of the team’s schedule or where he was supposed to be.

Make a morning flight was exceedingly difficult for Barnes. As recounted in
Terry Pluto’s lively book on the history of the ABA, the classic Barnes airline
story came when the Spirits played a game in New York and had an early flight
from LaGuardia Airport the next morning for a game in Norfolk. Naturally Barnes
was not at the airport. One of the owners, Donald Schupak, called Barnes at his
hotel and ordered him to get to the airport immediately. Barnes mumbled
something and went back to sleep.

Then the Spirits’ coach MacKinnon called and warned, “Marvin, if you don’t
get to the game, I’m going to have to suspend you. I’m not kidding this time.”

“Don’t worry, man,” Barnes answered and again went back to sleep.

When Barnes finally made it to LaGuardia, he had missed the 9:00am, 11:00am
and 1:00pm flights and there were no further scheduled planes to Norfolk.
Realizing he was in big trouble, Barnes begged the counter people at the airport
to help him and they were finally able to locate a pilot willing to make a deal
to fly him to Norfolk in a private charter plane. Landing in Norfolk, Barnes
jumped into a cab and arrived at the locker room ten minutes before game time,
opening his floor-length mink coat to reveal his Spirits uniform on underneath.

MacKinnon was so angry that he refused to start Barnes in the game, although
he put him in later and Barnes still ended up with 43 points and 19 rebounds. As
the game wore on a visitor appeared beside the Spirits’ huddle during each
timeout. It was the pilot demanding his charter fee and refusing to leave
Barnes’ side until he was paid. Barnes was finally forced to send the trainer
into the locker room for his checkbook and, with sweat pouring off his face and
his teammates and opponents waiting, write the charter pilot a check for his
fee.

The Merger

But by the end of the 1975-76 season, the ABA, with only seven teams still
operating, was in pretty desperate financial shape. One of the team owners
likened the ABA’s bargaining position to that of Japan at the end of World War
II. It was willing to do a deal at virtually any price. Fortunately for it, the
NBA, tired of losing star players to the ABA and apprehensive about the ABA’s
antitrust suit, was also willing to do a deal.

In marathon negotiations conducted in Hyannis, Massachusetts, a merger
between the two leagues was finally agreed. Only it was not a merger in any true
sense, merely an agreement by the NBA to admit (in return for an admission fee
of $3,200,000 each) the four strongest ABA teams – the San Antonio Spurs,
Indiana Pacers, Denver Nuggets and New York Nets. The remaining ABA teams not
being admitted – the Virginia Squires, Kentucky Colonels and Spirits of St.
Louis – were required to fold, but it was the responsibility of the four
admitted teams to buy them out.

The Virginia Squires actually shut down in the weeks before completion of the
merger. This turned out to be a financial mistake, a really big mistake, since
it meant the four admitted teams could avoid paying Virginia anything.

The Kentucky Colonels settled for $3,000,000. Their owner, John Y. Brown, had
made his fortune as CEO and major shareholder of the Kentucky Fried Chicken
restaurant chain. Brown, who had assigned his wife to run the Colonels, was
happy to get out at a reasonable price. His attention was already turning to
politics and he successfully ran for Governor of Kentucky a couple of years
later.

This left the Spirits, who protested right up to the eve of the merger that
they deserved to be admitted to the NBA. When they finally came to accept the
reality that this was not going to happen, the Silnas designated their partner
Donald Schupak to negotiate with the other ABA owners the Spirits’ buyout price.

The astuteness of Schupak’s approach was to focus on a form of payment
currently being devalued by the other parties but still having exceptional
future potential – NBA revenues from national television contracts. The four
teams admitted to the NBA would of course share in these revenues over the
long-term. However, as one of the onerous conditions imposed by the NBA, the
four admitted ABA teams were excluded from national (as opposed to home city)
television revenues for the first three seasons following the merger. This of
course significantly discounted the upfront value of these revenues at a time
when the four admitted ABA teams were desperate for cash, cash to pay their
$3,200,000 NBA admission fees, to pay off the teams that were folding, and to
pay player salaries and other expenses of their first NBA season.

Based on my own negotiating experience I also feel it was crucial that
Schupak’s request for a portion of national television revenues had a ring of
fairness to it. By all reports Schupak conducted his Hyannis negotiations on a
take-the-other-teams-to-the-brink basis. He knew the owners of the four admitted
teams had to reach a deal with him in order to complete their merger with the
NBA. On the other hand, if he pushed things too far, if he caused the owners to
feel he was being totally unreasonable, they might go back to the NBA
negotiators and convince them to admit the four teams without a paying off the
Spirits. Or, if excessively angered by Schupak’s negotiating position, the
owners of the four teams could simply say, “To hell with you and to hell with
the merger.”

But it would be hard for them to get too angry if Schupak in effect just
said: “We were all in the ABA together, the Spirits, the Spurs, the Pacers, the
Nuggets, the Nets, all of us. We suffered the losses together. We fought the NBA
together. And now when we are finally able to force them into a merger, all I am
asking is that we receive our fair share, our 1/7 share, of the ABA’s portion of
the TV revenues. Why isn’t that the right thing to do?”

For whatever reason – focus on the right form of payment, a ring of fairness,
or simply negotiating persistence – Schupak was able to prevail with his
television revenue demand. In exchange for the Spirits’ accepting that they
would not be included in the merger, the four admitted teams agreed to pay the
Spirits $2,200,000 in cash ($800,000 less than Kentucky), but with the further
agreement that the Spirits’ owners would receive 1/7 of each admitted team’s
share of NBA revenues from national television contracts. (The 1/7 share was
based on the fact that, prior to the merger, the Spirits were one of seven
remaining ABA teams.) Thus the Spirits’ owners would receive a total of 4/7 of a
share of NBA network television revenues. For how long a period would they
continue to share in these television revenues? In the legal language of the
agreement, “in perpetuity.” In other words, forever.

$13 Million Per Year

A few years were required for the outcome of Schupak’s deal to fully reveal
itself. In the 1970s, the NBA was not considered a prime television property. It
took the upsurge of television sports in general, and the rise to national
popularity of superstars like Larry Bird and Magic Johnson followed by the even
more popular Michael Jordan, for NBA television contracts to really heat up.
Also, as indicated, the NBA had denied the admitted ABA teams any share in
national television revenues for the first three seasons and thus the Spirits,
along with the admitted teams, had to wait four years for their first television
payments.

But once television revenue payments began, they built steadily. In the first
twenty years of payments, the cumulative amount received by the Silnas and
Schupak totaled some $50 million. Not a bad return on the $800,000 in upfront
cash given up in comparison with the Kentucky buyout deal. But $50 million was
just the beginning. During the1990s, leading sports attractions became crucial
to the television networks in building audiences for the remainder of their
schedules and the networks were willing to forego all profit, even suffer
losses, in order to outbid each other for multi-year football and basketball
contracts. The NBA’s $2.6 billion television package negotiated in 1997 resulted
in the revenue share of the Silnas and Schupak reaching a spectacular $13
million per year. And a new NBA television contract currently being negotiated
will likely result in their receiving an additional increase in the near future.

To put this in perspective, there are only a few professional teams in any
sport – in Major League Baseball, the National Football League or the NBA – that
earn $13 million of bottom-line, pre-tax profit. And each of these teams must
over an extended period invest many tens of millions to sign and develop players
and win fan loyalty. The right to receive $13 million a year automatically,
without the need to build a successful team, without the need for skilled
management or an extensive organization, without the need for capital or
risk-taking, is fantastically valuable. It is the equivalent of owning a senior
bond issued by the NBA paying yearly interest of $13 million, with an added
escalation feature that increases the interest pay-out as national television
revenues grow. Depending on prevailing interest levels, such a bond would have a
fair market value in the range of $200 million.

Further analyzing Donald Schupak’s negotiation with the four admitted ABA
teams, what was it that allowed him to realize such a spectacular result, a
capitalized value of $200 million negotiating on behalf of an almost defunct
basketball franchise that had cost him and his partners only $1.5 million to
begin with? Did he simply pull the wool over their eyes?

As I have discussed, the concept of the Spirits sharing in the television
revenues of the Spurs, Pacers, Nuggets and Nets was justifiable. Along with the
four admitted teams, the Spirits had borne the risks and the losses of the ABA,
had helped build the exciting play, fan loyalty and goodwill the NBA was now
willing to acquire (or, viewed more cynically, had helped fund the antitrust
suit the NBA now anxious to rid itself of). So the request for a share of
national television revenues was a fair and reasonable one.

But the goodwill and value the Spirits had helped create in the ABA would
dissipate in time. After a few years the exciting ABA players would be gone and
each admitted franchise would become like any other established NBA team,
dependant on its then-current success in building a successful core of players
and winning fan loyalty. By this logic, the Spirits’ share of national
television revenues should reasonably have continued for a term of years,
possibly for ten or fifteen years until the beneficial effects of the ABA’s
ten-year independent existence would be considered to have long since
disappeared. But not for fifty or a hundred years, not forever.

Representatives of four teams were negotiating with Schupak so there was no
reason for them to be at a disadvantage. Perhaps Schupak just had a better sense
of the value of perpetual payments. Or perhaps the Spurs, Pacers, Nuggets and
Nets were so focused on the moment, on getting their NBA deal done, that they
did not worry about financial effects many years down the road. Of course when
they started to pay out millions each year to the Silnas and Schupak, the
long-term nature of the deal they had made was brought home to them with
considerable emphasis. As the President of the Pacers recently described it, “In
perpetuity is a long time.”

As the annual payments grew and grew, the four teams hired leading law firms
to develop every conceivable argument under which their agreement with the
Spirits’ owners could be reinterpreted, modified or terminated, but to no avail.
They tried for years to buy out the revenue stream, but also to no avail. The
deal negotiated by Donald Schupak – my nomination for the greatest deal ever by
a “regular guy,” a small business owner negotiating without government influence
or a multi-billion-dollar company behind him – continues in effect.